As more developing countries tap international financial markets and more countries draw upon alternative sources for sovereign financing, borrowing needs to be managed prudently, especially in a challenging global environment. The Monterrey Consensus welcomed consideration of an international debt workout mechanism. However, proposals for a statutory mechanism did not receive sufficient political support. The focus has been on market-based solutions, such as contractual clauses in bond contracts and reform of IMF lending into arrears policy, and "soft-law" approaches such as principles and guidelines for debtor and creditor responsibilities.
Lacking sufficient political support to develop a proposed comprehensive sovereign debt workout mechanism, the international community has focused on encouraging contractual improvements to facilitate restructuring of insolvent obligations to private creditors. In addition, to further encourage cooperative behaviour, a number of “soft-law” approaches have suggested principles and guidelines for debtor and creditor interaction.
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In October 2014, the IMF endorsed key features of enhanced collective action and pari passu clauses in international sovereign bond contracts. These features are meant to reduce issuers’ vulnerability to holdout creditors in case of a debt restructuring. Between October 2014 and end-September 2017, 245 of the 338 international bond issuances (approximately 87 per cent of the nominal principal value of new internationally issued sovereign debt) included such enhanced collective action and modified pari passu clauses. However, with only about 27 per cent ($294 billion out of $1.1 trillion) of the outstanding stock of international sovereign bonds having the enhanced clauses, a significant stock without these provisions remains and will decline only gradually (see here). Moreover, the enhanced clauses only apply to bonds; a significant portion of developing countries also have borrowed from banks, to which these clauses do not apply.
While an aim of the contractual reforms was to reduce the ability of non-cooperating bondholders to undermine voluntary restructurings, investors in distressed debt have a role to play in resolving unsustainable borrowing situations. Distressed debt investment funds can provide liquidity in secondary markets for sovereign bonds. However, a subset of these funds that buys the distressed debt at a large discount with the intent to recover the full face value through litigation has made restructurings extremely difficult. Thus, recent legislative efforts have been made to curtail this type of investing, including the Law on Deterring the Activities of Vulture Funds, adopted in Belgium in 2015. A spread of such legislation to other jurisdictions could help to further discourage disruptive behaviour and should aim to strike the right balance between further discouraging disruptive behaviour and preserving secondary-market liquidity.
In the absence of “hard” law oversight of workouts from sovereign insolvency, a number of forums have sought to specify principles and guidelines that, while not mandatory, could, through voluntary adoption, become accepted standards that courts might choose to enforce. Indeed, the Addis Agenda committed Member States to working towards a global consensus on guidelines for debtor and creditor responsibilities in borrowing by and lending to sovereigns, building on existing initiatives.